Technical vs. Fundamental Analysis
Your Roadmap to Smarter Investing
Technical Analysis
Technical analysis involves studying market behavior, primarily through charts, to predict future price trends. Investors using this method analyze the effects of market movements (price changes) by identifying historical trends and patterns on charts to forecast future market behavior. Technical analysis is based on three core principles:
A. The Market Discounts Everything
Proponents of technical analysis believe that all factors influencing price—economic, political, or otherwise—are already reflected in the price. This stems from the idea that price movements capture shifts in supply and demand. Instead of analyzing the causes of price changes, technical analysts focus on charts and indicators to predict market direction. They acknowledge that economic conditions drive trends but argue that studying price charts is a simpler and more effective way to understand and anticipate market behavior.
Pros: Analyzing charts across various timeframes simplifies decision-making by visualizing market trends and emotions. As a form of time-series analysis, it has mathematical grounding and enables quick decisions without delving into complex economic data.
Cons: The market cannot fully discount unpredictable human behavior, such as whether investors like Warren Buffett or individual traders will increase, hold, or exit positions. Price ultimately depends on new order flow, not just historical data visible on charts.
B. Prices Follow Trends
Technical analysts aim to identify trends—directional price movements—early to capitalize on them. The assumption is that a trend is more likely to continue than reverse, allowing traders to buy during uptrends or sell during downtrends.
Pros: This principle holds, especially on longer timeframes (4-hour charts and above). Sayings like “the trend is your friend” and “don’t fight the trend” reflect its reliability.
Cons: Trends are often clearer in hindsight than in real-time, making forward prediction challenging. Technical analysis involves subjective interpretation of patterns, and slight changes in observation periods can lead to vastly different decisions. Formations are not always clear, making technical analysis more art than science.
C. History Repeats Itself
By studying charts, analysts identify recurring patterns driven by consistent human behavior in specific situations. Recognizing these patterns in current market data helps predict future price movements.
Pros: Essential for short-term trading (2-hour, 4-hour, or daily charts) and scalping (2-minute to 30-minute charts), where fundamentals and news have minimal impact. It’s the simplest approach for beginners, requiring mastery of just one or two indicators. Human emotions like fear and greed drive repeatable behaviors.
Cons: History never repeats exactly. Markets evolve, as do investor behaviors with experience, making pattern prediction difficult. The apparent randomness of price movements can frustrate attempts to identify clear formations.
Fundamental Analysis
Fundamental analysis predicts future price movements by evaluating economic, political, and environmental factors affecting an instrument’s supply and demand. It focuses on the underlying asset (stocks, bonds, commodities, currencies), its issuer, and the broader economic environment. By assessing financial health, strengths, weaknesses, and growth prospects, it determines whether an instrument is a worthwhile investment. This approach combines detailed analysis of the asset and its issuer with macroeconomic considerations to select instruments with the best potential for price appreciation.
Fundamental analysis involves several stages:
A. Macroeconomic Analysis
Companies and markets operate within a social, political, and economic context. This stage evaluates the broader environment, including economic cycles, budget deficits, balance of payments, GDP growth, inflation rates, central bank policies (interest rates, currency policies, money supply), and government fiscal and tax policies. It answers whether investing in a specific market (e.g., equities) is viable.
B. Sectoral Analysis
This assesses the attractiveness of investing in a specific industry. It evaluates profitability, risk, and the sector’s position in the economic cycle relative to macroeconomic conditions. Factors like technological advantages or regulatory protections are also considered to gauge growth potential compared to other sectors or the broader economy.
C. Situational Analysis
This evaluates an instrument within its sector, focusing on non-financial factors such as management quality, marketing strategies, production capabilities, workforce expertise, future strategies, and the issuer’s strengths, weaknesses, opportunities, and threats.
D. Financial Analysis
This assesses the overall economic performance of a company or the conditions for a commodity/currency, typically through ratio analysis.
E. Valuation
Valuation estimates an instrument’s intrinsic value based on the above analyses, projecting this value into the future. Accurate models and reliable data are critical, as poor inputs lead to flawed valuations (“garbage in, garbage out”).
Benjamin Graham, a pioneer of fundamental analysis, argued that financial analysis is not an exact science, as unmeasurable or unknown factors can skew valuations. His value investing philosophy rests on four principles:
- A stock’s value derives from the company’s overall value, calculable through its financials.
- Market prices reflect supply and demand, often driven by irrational factors like hype, fear, or greed.
- Consequently, market prices may deviate significantly from intrinsic value.
- Over time, markets tend to correct toward intrinsic value, though this can lead to overvaluation and subsequent corrections.
Warren Buffett, a prominent advocate, emphasizes determining a company’s true value and buying at a fair or discounted price. His investments often rely on discounted cash flow valuations. His three key tips:
- Buy the business, not the stock: Invest in fundamentally strong companies with capable management and solid liquidity, treating purchases as ownership stakes.
- Ignore the market: Buy undervalued companies with your own capital, regardless of technical signals. Large purchases (like Buffett’s) can drive prices up due to reduced supply.
- Don’t worry about the economy: Strong companies outperform competitors, especially during downturns.
Pros: Thorough fundamental analysis can uncover undervalued opportunities well before the market (or technical analysts) recognizes them. Accurate valuations, backed by robust data, align with market corrections toward intrinsic value, especially for large-scale investors like Buffett.
Cons: Fundamental analysis assumes current trends will persist, but economic shifts can disrupt projections. Critics argue it struggles to account for risks like interest rate changes, currency fluctuations, inflation, or political and regulatory shifts, which can significantly affect valuations.
From my perspective, fundamental analysis is less about labeling instruments as “good” or “bad” and more about identifying liquid assets whose value changes can be estimated based on defined inputs.
Technical Analysis vs. Fundamental Analysis
Investing is like driving a car—you can’t rely solely on one side mirror. Fundamental analysis answers “what to buy,” while technical analysis addresses “when to buy” and “when to sell.” Building an investment portfolio typically involves two phases:
- Screening: Selecting instruments based on fundamental criteria, such as liquidity, trading hours, jurisdiction, dividend yield, credit ratings, revenue growth, commodity production predictability, or central bank policies.
- Technical Analysis: Analyzing charts of screened instruments to make final buy or sell decisions.
Investment tools and techniques follow trends. At times, investors favor technical analysis; at others, fundamental analysis. As markets evolve with new instruments, industries, and social dynamics, no single approach guarantees success. There are no infallible experts, indicators, or oscillators. The best strategy is to leverage the strengths of both analyses to create a personalized investment system.
Portfolios should include instruments with strong fundamentals, selected using technical criteria. Prices are driven by fundamental factors and emotional factors, with technical analysis mathematically describing their interplay. However, correlations between these factors can distort valuations—analysts may adjust price targets based on technical signals or market sentiment, sometimes ignoring fundamentals. Emotional factors, like fads for tech stocks, gold, or cryptocurrencies, can disconnect prices from intrinsic value, potentially inflating speculative bubbles that lead to market crashes.
Investors who integrate technical methods into a broader system grounded in sound fundamental analysis and precise valuations will find a path to consistent, repeatable success—not just in stock markets but across asset classes. Many investors act impulsively, buying or selling without a clear strategy. Consider whether you can afford such reckless decisions.
Mike Voss